Written and copyright © 2009-2013 by Thomas N. Bulkowski. All rights reserved.
For years I have been looking for flat base structures and found them only recently. Why? One reason is the end of the 2008 bear market. Price moved horizontally for several months
in many stocks, creating a target rich environment. But the real reason I did not find any is because I was using the logarithmic scale on my charts and not the linear or arithmetic
scale. Switching to a linear scale when searching for flat bases made all the difference. Let's start with an example of what a flat base looks like.
Flat Base Example
The chart of Cache on the daily scale provides a good example of a flat base. The bottom of the region need not be flat nor must the top appear flat. However, it is clear that price
moved horizontally from November 2008 to March 2009, creating what looks like a flat region.
The price path, shown in black, reminds me of an airplane in trouble, making an emergency landing. It hits the runway, bounces to a stop and then the trucks arrive. Mechanics in white
overhauls pile out of the trucks, check the oil, fill the tires, clean the windshield, and the plane is ready to go. In late March, the plane takes off, and away she goes.
That is how price is supposed to travel. It remains flat during the flat base but after that, price should move up. The rise is often a choppy affair as you see here, not a straight
line run mirroring the drop in mid September from 12 to 7. The rise can be just as swift as the decline, but that would be unusual.
Flat Base Log Scale
Compare the first image with this one and notice the vertical price scale shown on the left. The divisions are not the same height because they are logarithms of price,
whereas the prior chart shows evenly spaced numbers. Treatment of price changes how the chart appears. With large price moves, as in this drop from 13 to 2, the linear chart will
not show you the detail like the log scale does. That is why I prefer the log scale when looking at charts. However, when searching for flat bases, I switch to the linear scale.
Flat Base Identification Guidelines
What should you look for when choosing a flat base? The following guidelines will help in your search.
- Switch to the linear/arithmetic scale.
- The time scale can be daily, weekly, or even intraday.
- Look for price moving horizontally.
- The tops and bottom of the flat base need not be horizontal as required in rectangle bottoms.
- The length of the flat base can be any duration, depending on your scale (intraday, daily, weekly). The longer it is the better.
In my book,
Encyclopedia of Chart Patterns, Second Edition,
pictured on the right, I examined rectangle bottoms, which are a special case of a flat base. I discovered that rectangle bottoms with upward breakouts in a bull market shorter
than the median 65 days (about 2 months), had price climb an average of 41% before the trend changed (before price dropped at least 20% or it closed below the bottom of the pattern).
Rectangle bottoms longer than the median 65 days showed price climb 51%.
In other words, the average rise was 24% higher for longer rectangle bottoms than shorter ones.
Flat Base Trading Tactics
Now that we know what to look for, how do we trade the flat base? Here are some tips.
- Select a flat base longer than 65 days (or price bars) for the best performance
- Draw a horizontal line along the price tops
- When price closes above this line, then buy.
- You will likely want to place a stop closer than the bottom of the pattern to narrow your potential loss.
- If price closes below the bottom of the flat base, then close out a long position.
- Measure rule for upward breakouts: Use 85% of the height of the flat base, projected upward from the top of the pattern.
- Measure rule for downward breakouts: Use 50% of the height of the flat base projected downward from the bottom of the flat base. If the target is below 0, then discard it.
- The measure rule should serve as a minimum price move, but look for nearby support or resistance that might halt price.
Flat Base Measure Rule
The above Trading Tactics suggested a way to predict how far price will rise or decline. That method is called the measure rule, and it is often based on the height of a chart pattern. The
following information comes from rectangle bottoms.
Follow these steps to predict a price target, referencing the associated chart.
- Compute the height between trendlines A and B in the figure to the right.
- Multiply the height by 85% (0.85) for upward breakouts or 50% for downward ones.
- Add the result to the price of the top trendline (A, upward breakouts) or subtract it from the bottom trendline (B,
downward breakouts) to get a target price (C).
For example, if the top trendline is at 10 and the bottom one is at 8, the height is 2. Multiple 2 by 0.85 to get the adjusted height: 1.70. Add 1.70 to the price of the top
trendline, 10, to get a target of 11.70.
Should the flat base breakout downward, the target would be 8 - 1.00 or 7. The 1.00 comes from the height of 2 multiplied by 50%, since downward
breakouts do not reach their full height targets as often.
Instead of multiplying the height by 85% or 50%, you can use the entire height in the calculation to get a maximum price target. In this example, the upward target would be 10 + 2 or 12
and the downward target would be 8 - 2 or 6. Price should hit the upward target 85% of the time and reach the downward target half the time.
For downward price targets, if the computed value is below 0, then ignore it. This can happen with tall flat bases trading near 0.
Consider taking the height and converting it into a percentage of the breakout price just as a sanity check that the measure rule doesn't have you flying too close to the sun or
drilling down to the earth's core.
Since the top of the flat base is 10 in this example, the percentage would be 1.70/10 or 17%. That sounds like a reasonable potential move. If you were to get, say, 30% or 50%,
then those numbers sound too far away to be reliable. In all cases, look for nearby support and resistance where price may stall.
-- Thomas Bulkowski
Other Flat Base Examples
Written and copyright © 2009-2013 by Thomas N. Bulkowski. All rights reserved. When God created man, she was only testing.